Carr's Call: The $A has done its dash

The $A has had its run ... now we’re headed for range trading, but that won't impede a recovering stockmarket.

PORTFOLIO POINT: The Australian dollar will likely be range-bound for now, but that won’t spoil the sharemarket rebound.

Two significant questions arise out of the Reserve Bank’s decision to hold rates steady on Tuesday. If the RBA is done (at least for the time being), is the Australian dollar spike we saw following the decision a sign of things to come? Moreover, if it is, does it herald an underperformance of the All Ordinaries coming into the fiscal cliff?

Now obviously the reason there was such a sharp spike – 80 pips in 15 minutes (see chart 1) - is because the accompanying statement caught most off guard. For me, it showed a material evolution in the RBA’s thinking and a heightened degree of confusion.

Sure, most people still expect another cut at some point, largely based on forecasts of ‘ongoing’ economic weakness, and that may come, but it may be some way off. In any case, I don’t think the statement really alluded to this. That the RBA board thinks the economy needs stimulus is clear; what they’re not sure about is how much, or at what level rates should rest. That is whether the economy needs further stimulus. I suspect that’s because, and as indicated in the press release following the decision, it was quite surprised by the stronger-than-expected CPI number and stronger global economic outcomes.

The change in the board’s thinking is summed up in the last paragraph of the statement: “with prices data slightly higher than expected and recent information on the world economy slightly more positive, the board judged that the stance of monetary policy was appropriate for the time being”.

It could be that “for the time being” turns out to be quite a while, and certainly another cut is no longer guaranteed if the CPI doesn’t moderate and the global recovery continues (the board also noted ongoing strength in consumer spending). I mean we don’t get another update on the CPI till January, and even then it may not be sufficient information given the RBA said it is waiting to see what effect earlier rate cuts have. The board is really just telling us it is digesting things at the moment, and a steady hand for a lengthy period is a real possibility.

First things first. I’m sceptical that if it turns out the RBA is on hold that this would be a signal for a renewed or sustained surge in the AUD.

Chart 2 shows that the AUD has tested $1.10 twice – early to mid-2011 - and on both occasions the driving factor was a spike in inflation and the widely held expectation the RBA would hike rates. At this point in time, a rate hike isn’t even on the table. That would strongly argue against any move to that level, at least in the near term.

So how high could the AUD go? Well the chart shows three other key levels. The first is around $1.04, where we are now, $1.055 and $1.075 (these are approximate). Now $1.055 was last reached in August. Recall we had just seen strong GDP figures, and there was talk of a Spanish bailout, but there was nothing earth shattering. Consequently, this is an entirely plausible and easy target for the currency. Especially, and as I showed in my piece of October 29 Ride the fiscal cliff wave, speculative traders appear to lift their long (or bought) positions in the AUD back to highs, once the RBA has cut rates. I don’t have the latest numbers but after the RBA’s recent announcement I expect those long positions to be approaching previous highs.

The next significant level is the $1.075 mark. We were last here in February of this year – on a renewed bout of global optimism. Looking at the headlines I don’t think we have this in store just yet, what with the fiscal cliff just ahead of us and Europe, inexplicably, beating the crisis drums again (although, as I’ve discussed, I think the crisis is largely over now). We saw just yesterday that the mere mention of the cliff (post the presidential election) was enough to put a cap on the AUD.

For mine these are sufficient to restrain the AUD in the short term, with two other reasons overlayed.

  1. There is talk the RBA is ‘passively’ printing money, although there is actually no evidence of any accumulation of FX reserves. So for me, this is just a false rumour. But rumours can have effect and feed speculation it might do this.
  2. Regardless, there is an implicit threat from the RBA that if the AUD gets too high it will cut again.

Noting this, it’s also true to say that the near-term downside to the unit is probably limited as well – the Aussie economy is better than expected, the global economy better and inflation higher (recall my medium-term view is for AUD weakness). Most likely we are still looking at a range-bound AUD, but with a higher resistance level at the $1.055 mark.

Now investors shouldn’t be spooked by this. I know there is a common perception that the strong AUD is weighing on the Aussie market, and any indication that it isn’t coming down could be seen by some as a sign of renewed underperformance. I don’t think this is the case though, and I outlined the reason why in my piece of October 1 A rate cut won’t cut it for investors.

To that I’d add that the usual strong correlation between the AUD and the our stockmarket has returned anyway. It actually seems that what is good for the goose is now again good for the gander. The way it had been previously, which makes sense right? A sign of economic health – good for stocks, good for the currency.

So then to the extent that the AUD continues to push higher, investors should not be concerned about a renewed push to previous highs. That said, even if I’m wrong on that, the recent strong positive correlation between the All Ords and the AUD suggests it probably wouldn’t stand in the way of any further equity rally anyway (or an underperformance in the case of a fiscal cliff correction), despite ongoing fears.